Consolidated Water Co Ltd (CWCO) 2012 Q3 法說會逐字稿

Hello and welcome to the Consolidated Water Company third-quarter 2012 operating results conference call. All participants will be in a listen-only mode. (Operator Instructions). After today's presentation, there will be an opportunity to ask questions. Instructions on how to ask your questions will be provided at that time.

This conference call may include statements that may constitute forward-looking statements usually containing the words believe, estimate, project, intend, expect, or similar expressions. These statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements inherently involve risks and uncertainties that could cause actual results to differ materially from the forward-looking statements.

Factors that would cause or contribute to such differences include but are not limited to continued acceptance of the Company's products and services in the marketplace; changes in its relationship with the governments of the jurisdictions in which it operates; the ability to successfully secure contracts for water projects in other countries; the ability to develop and operate such projects profitably; and other risks detailed in the Company's periodic reports filings with the Securities and Exchange Commission.

By making these forward-looking statements, the Company undertakes no obligation to update these statements for revisions or changes after the date of this conference call. Please note this conference is being recorded.

I would now like to turn the conference over to Mr. Rick McTaggart. Mr. McTaggart, the floor is yours, Sir.

Thanks, Mike, and good morning, ladies and gentlemen. David Sasnett, our Chief Financial Officer, is also on the call today and we appreciate you taking time to join us.

Overall revenues of the Company increased by 24% compared to the third-quarter 2011, reflecting increased revenues from all three of our business segments. This is a very positive change compared to the second-quarter 2012 results which were adversely impacted by high rainfall amounts in Grand Cayman, thus causing our retail sales to be depressed in the second quarter.

Consolidated gross profit also increased by 31%, reflecting higher overall revenues and higher margins in our Retail segment. The Company continues to vigorously pursue various business expansion opportunities in existing markets as well as new markets, and I will discuss those opportunities in more detail later in the call. Subsequently, or consequently, we used a portion of these increased profits from the third quarter to fund business development activities, resulting in higher administrative expenses compared to the third quarter of 2011.

Retail revenues increased by 8%, compared to the third quarter of 2011, reflecting a 7% increase in the number of gallons sold to our customers in Grand Cayman. This is more consistent with our expectations and builds on the 14% increase in retail revenues that we achieved in the third quarter of 2011. This increase also compares favorably to the drop in retail revenues in the second quarter of this year due to unusually high rainfall, which obviously did not impact the third quarter.

Gross profits of our Retail segment increased by 20%, reflecting higher revenues during the quarter. It is worth noting that our retail revenues have become a smaller part of our total revenues over the last few years, as we have grown our Bulk business segment. Retail revenues represented 40% of our total revenues in the third quarter of 2011 and now represent 36% of our total revenues this past quarter.

Investors will be aware that we have been operating our retail business in Grand Cayman since July 2010 under several short-term extensions of our 1990 water production license and have attempted to secure a long-term extension of the license through discussions with the government of Cayman Islands and its statutory authority, Water Authority Cayman. These discussions have proven to be much more challenging and complex than anticipated and have not progressed since early 2011.

In an effort to resolve these issues as well as to get clarity on certain provisions of two laws that were passed by the Cayman government in January last year, we filed in July an Application for Leave to Apply for Judicial Review with the Grand Court of the Cayman Islands stating first that certain provisions of the amended laws appear to be incompatible; secondly, that the Water Authority Cayman's role as the principal license negotiator, statutory regulator, and our business competitor creates a clear and irreconcilable conflicts of interest for the Authority; and lastly, that the Authority's decision to replace our existing rate structure within RCAM model, which is a rate of return on invested capital model, this was predetermined and unreasonable.

On October 22, the Company was notified that the Grand Court of the Cayman Islands had agreed to consider the issues raised by the Company in its Application for Leave to apply for Judicial Review. Shortly after that, we were surprised to learn in the local press that on October 30, the Cayman Islands government amended the base water and sewage rates charged by our regulator, Water Authority Cayman, to include an annual inflation adjustment mechanism that is functionally the same as the inflation adjustment mechanism included in the Company's existing 1990 license. This particular rate adjustment mechanism has been the primary source of contention in our negotiations with Water Authority-Cayman since late 2009.

In addition, the government amended Water Authority Cayman's rates for sewage services to include a monthly energy adjustment charge that allows the Authority to increase or decrease its sewage rates to reflect monthly changes in energy costs. This new energy adjustment charge is also functionally similar to the energy adjustment charge in our 1990 license.

And finally, the government immediately increased the Authority's base water and sewage rates by an average of 9.2%. We believe that as a result of these fundamental changes, the Water Authority's rate structure is now in line with the rate structure in our 1990 license. In our opinion, such changes are inconsistent with the Authority's previous assertion that a rate of return model is in the best interest of the public.

Since we are not aware of any change to the Authority's previously stated position that our new license should be based on a rate of return model, in spite of the Authority having now adopted our rate structure itself, we expect that the Company of the Cayman Islands government and the Water Authority will have the opportunity to present their positions to the court in a trial proceeding, and we will continue to update investors as this unfolds.

And, incidentally, we are not aware of any court date being set for these trial proceedings at this time.

Our bulk revenues increased by 35% compared to the third quarter of 2011 and now represent approximately 63% of our total revenues. This increase reflected a 36% increase in the number of gallons sold to our customers and was primarily due to the expansion of our Blue Hills plant in Nassau and, to a lesser extent, to revenue growth of our bulk businesses in Belize and the Cayman Islands, which achieved 15% and 5.5% increases respectively in revenue this past quarter compared to the third quarter of 2011.

Gross profits from our bulk businesses grew by 37%, compared to the third quarter of 2011, reflecting higher revenues. And gross profit margin remained consistent at 22% of revenues for our Bulk segment.

Services revenues increased by about $105,000 or $205,000 this last quarter compared to $70,000 in the third quarter of 2011, reflecting an increase in management fees that we earned from our BVI affiliate.

We received written confirmation last week from the BVI government that it will pay our BVI affiliate approximately $6.7 million by the end of the year which represents the amounts outstanding from the September 2009 court award, relating to the Baughers Bay plant dispute plus legal expenses and accrued interest. The Company expects to book approximately 43.5% of this amount as equity earnings from our interest in the BVI affiliate when these amounts are received and obviously this is very positive news.

The BVI affiliate will also continue to pursue additional compensation that was awarded by the appellate court which relates to the value of the Baughers Bay plant and equipment at the time that the plant was turned over to the BVI government in March 2010. And again, we will keep investors informed as this develops.

Just looking at projects opportunities as reported in the press release on Friday, the Company's business development activities in Mexico and Asia are proceeding as expected. On August 31, our Mexican subsidiary, NSC Agua, and Doosan Heavy Industries and Construction Ltd. extended a memorandum of understanding for 18 months from August 19, 2012, during which time Doosan will provide, install, and operate a pilot plant and collect water quality data from the proposed feed water source at the electricity generation plant in Rosarito Beach, Mexico.

Doosan began installing the pilot plant about two weeks ago and it should be operational within the next two weeks. Several of our Directors recently visited the site and reviewed first hand the pilot plant being assembled and met with local officials. We are anxious to begin collecting valuable data from the pilot plant that will ultimately assist us in the design of the 100 million gallon per day Rosarito desalination plant.

In Bali, Indonesia, work is proceeding on the construction of the first phase of a 1.5 million gallon per day seawater desalination plant and distribution system and a rapidly growing resort area on the island. And we expect this first phase to be operational early next year. This particular area of Bali suffers from chronic water shortages while, at the same time, enjoying tremendous development growth. We believe this particular market provides an excellent opportunity to use our business model that we have employed in the Caribbean for almost 40 years to provide a total water solution for the people of Bali.

Now, Mike, I would like to open up the call for questions.

(Operator Instructions). Tim Fronda, Sidoti & Company.

Good morning. Thanks for taking my questions. Just on the G&A expense, can you go into that a little bit, what they relate to? Are they added personnel to prepare for new business or what exactly are those expenses?

Tim, the additional compensation costs, we have hired a Chief Operating Officer to improve the quality of our operations and raise the level of our efficiencies and also to set the foundation for growing business in new markets. Then, we have also upgraded our IT personnel. That goes hand-in-hand with some of the things we are doing in the factories and plants to try to improve efficiencies there. Then most of the other SG&A costs relate to business development efforts, both in Bali and also in the Bahamas, where we are looking at a new joint venture there.

So this is more of the range we can expect going forward, I guess?

Well, the business development expenses themselves probably will decline somewhat. Most of those funds were upfront costs and monies we are spending now, both in Mexico and especially in Asia, are the type that we would capitalize. And most of the money we are spending in Bali right now is for plant construction.

So I would think, if anything, the business development costs would decline. But the other costs relative to -- and personnel costs, I think that is -- we are at a new level now. And what you see in our filings is probably pretty consistent with what you see going forward.

And with respect to the plant in Bali, do you think you'll have to wait for this plant to be producing before you look to expand in other parts of Asia or are you going to go ahead and expand before that?

Well, as we have disclosed, the plant presently we have not contracted for its production yet. Introducing desalinated water to Indonesia is somewhat -- they haven't used it before to a great extent. There is some use of desalinated water in parts of Jakarta and other areas of Indonesia. But in Bali itself desalinated water has not really been introduced there to any great extent.

So we want to teach the market of the benefits and but we would expect assuming that we could prove our product is viable and that we make good water and it is relatively inexpensive, we would expect to increase both the production capacity of existing plant and look for new opportunities pretty quickly.

We have got to teach them a little bit about what we do and our expertise and teach them that desalinated water is of high quality. And once we do that we think the market presents a very good opportunity for us.

Got you. Great. Thanks for your time.

(Operator Instructions). John Baer, SKA Financial Services.

Good morning. Want to follow up on the Bali plant there. You are at 1.5 million a day. What do you think the ultimate upside of that particular facility could be or is that pretty much it for this particular location?

Well, this location, we probably could expand it beyond 1.5 million gallons if the demand is there and we think potentially the demand is there. What we are looking at it, though, is the entire Asian area and particularly other areas of Bali and other areas of Indonesia.

That's a growing economy. They have water problems in several of the islands there. I mean if you look at Indonesia itself, it is a country with more than 11,000 islands whose economy is growing pretty rapidly.

So -- and then also other areas of Asia where we see similar opportunities. The productive capacity that exists over there is much larger than what we are looking at right now as far as opportunities in the Caribbean. So we are building a 0.5 million gallon a day plant. Once we sell out of that capacity, we would expand the plant to 1.5 million gallons. And hopefully we will be able to show the people both in the private sector and public sector there that we can deliver high-quality water at a reasonable cost and, therefore, other opportunities will open up for us.

So if everything kind of went without too many hitches, when do you think that would be up and fully functional then?

Well, we could have 1.5 million gallons going I would say within 12 months. We should have the 0.5 million gallons a day plant going up by the first quarter of next year. And to expand it would take us about six to nine months.

And are the contracts still in negotiation on that as far as what you would receive for that? Or is (multiple speakers).

To a certain extent, yes. Our discussions with potential customers are such that we certainly wouldn't be building a plant if we didn't think we could sell the water at a good profit. But these guys are a bit skeptical. When you go to Indonesia, none of them consolidated the water.

So they are waiting to see that we can actually do what we say we can do. Then they are willing to talk to us about a long-term supply contract. But for all the exposure we get in the local market and in the Caribbean, it is kind of humbling to go over there and find out that people don't know who we are. And so once we demonstrate our capabilities, we feel confident we will be able to get a lot of business there.

Well, I would think your business model that you have in existence in the Caribbean would translate pretty well. I mean, that's -- I guess I have a hard time understanding why they can't see that it works in the Caribbean, so why wouldn't it work in Bali, so --.

Well, we thought of the ability to -- we thought the fact that we were a public company would be all we would need to prove that we could do this over there. But I guess people have moved into the Bali market and not delivered on what they have claimed to be able to deliver on. So there's a bit of skepticism there in general about foreigners coming in and doing business there. And we are just trying to overcome that skepticism.

Is that at the government level or at the local level?

No, I think it's --

It's just a customer level.

It's a customer level, not the government level. The government is very difficult to deal with there. You know it's just the typical government bureaucracy. To get anything through the government there takes a while. But we are dealing directly with resorts. And the resorts are such that they won't commit to us in creating liability for themselves until they are sure we can actually meet their needs. Because once they commit to us they may close off all alternative supplies of water.

But most of the customers we have talked to are very positive about what we are offering them. They are just waiting for us to actually be able to deliver it. And then once we can I think we'll sign-up contracts fairly quickly.

So, in that comment then about the government versus the private sector there, are you -- are there any roadblocks from the governmental agencies for permitting and getting this up and running? In other words, if you satisfy your private sector customers, there shouldn't be any obstacles going forward then?

We haven't encountered any yet and we are actually trying to deliver water to an area where the government has acknowledged they are going to have problems supplying this area.

So, we -- if you do any kind of research on the water situation in Bali, you would be surprised to find out that even though it is a tropical island, they have huge chronic water shortages because of the way they manage their existing water resources. And it's an island that is still undergoing tremendous development. So there's not many roadblocks from the government to date, no, and we don't expect any. We are actually trying to supply water to areas where they really can't meet the demand.

Very good. And one last quick question. On the Cayman thing, do you anticipate -- I know you said there was no date set for this court review. Do you think it is likely or would you reach out to the government agencies and sit down and say, okay, you basically made some changes to your proposals that kind of fit with what we have been arguing all along, so can we just kind of get this straightened out and move forward? Is that something that might happen?

Well, I would love that to happen. We will just have to see how it plays out.

So in other words, you don't have any sense one way or the other whether they would be willing to accommodate -- in other words, if you reached out with them, and said, look, okay can we accelerate this? I mean, right now it sounds like you are just sitting in limbo waiting for some kind of the date for a trial which could be three months, six months. Is that a fair statement?

It could be as long as that, yes. It is hard for me to say at this point whether they would be receptive to us reaching out. I mean, I would like that to happen and if there is an opportunity for us to do that, we will take advantage of it. In the meantime, sometimes it's hard to -- once you're in a court situation -- to get the government to talk with you. I mean, they feel more guarded about things. So we'll just have to see how it plays out.

Good. Thank you.

Gentlemen, it appears that there are no further questions at this time.

All right, well, I'll just make a quick closing remark and thank everybody for joining us today. And we certainly look forward to speaking with you early next year when we release our annual results.

And we thank you, sir, for your time. To access the digital replay of this conference, you may dial 1-877-344-7529 or area code 412-317-0088 beginning at about 12.30 p.m. Eastern time today. You'll be prompted to enter a conference number, which will be 10020201. Again that number is 10020201. Please record your name and company when prompted.

The conference is now concluded. We thank you all for attending today's presentation.

At this time you may disconnect your lines. Thank you, and take care, everyone.